Reconstruction bonds could give the Greek people a stake in their country’s finances

Alain De Crombrugghe, Eric De Keuleneer15 March 2012

Even with the latest bailout and debt restructuring, Greek debt is still projected to be 120% of GDP by 2020. With no access to foreign markets, Greece will have to fund any future deficits by calling on more funds from foreign governments or international institutions. This column suggests a novel solution: force ordinary Greeks to save some of their earnings by purchasing government bonds.

Last month’s meeting in Brussels and this month’s agreement on a bond exchange have paved the way for a significant restructuring of the Greek debt (Eurogroup 2012).1 The write-offs of the private and public creditors have been adjusted to the possible rate of growth of the Greek economy with the objective to reach a debt-to-GDP ratio of 120% by 2020. Nevertheless this target includes an expected primary deficit in the first two coming years and a deficit due to the interest charges in the subsequent years. Given that Greece is not expected to recover access to the financial markets soon, the planned deficit will actually be financed by the official creditors.

An alternative to more foreign borrowing

A call on domestic savings may be an alternative way to finance a part of the expected Greek budget deficit. In the current exceptional circumstances, the placement of the bonds could be combined with the wage and price moderation policies which are part of the conditions for the debt reduction programme. In the long run, a domestic bond market would make economic sense. In the short run, the Greek people could be made more aware of the economic performance of the country by seeing that the value or tradability of the bonds is linked to some performance indicators.

It is hoped that wage moderation will enable Greece to recover a place on European and world markets for its goods and eventually be able to sustain a higher consumption level at world prices after years of welfare artificially built on badly used subsidies and easy borrowing in euros.

A part of the initial wage adjustment could take the form of the compulsory payment of a small share of net wages in bonds instead of cash.

Such unusual issues of government bonds may be seen as forced savings in other circumstances, but they could fit in a temporary adjustment programme.

The bonds could be called ‘reconstruction bonds’, but beside their temporary compulsory character they would share most of the characteristics of standard government bonds, including the potential of future higher consumption.

As a first characteristic, the pricing of the bonds should reflect the pricing conditions currently faced by Greece: the interest rate should thus be slightly lower than the interest rate paid by Greece to its official creditors, whose task is indeed to set a ceiling on the borrowing costs of countries in trouble. Such a cost would make the bond attractive to the government and would not cheat the domestic holders, paving the way for a return to market borrowing. If any seniority rights are considered, it would be wise to treat the reconstruction bonds at par with the official creditors’ loans.

A maturity of the order of five to seven years is a popular maturity in countries that manage to sell bonds to willing domestic savers. Very short maturities would not help the public finances, while very long ones would not be perceived as credible or useful by the general public. Interest should be paid in cash at least annually to create confidence. Before 2020, redemption at maturity could be in cash or in bonds. Compulsory redemption in bonds would only occur if some key targets of the adjustment programme of the country are not yet met. Such targets could be set on government tax revenue, on gross exports of goods and services (currently at an abnormally low 20% of GDP), or on spreads for private loans.

Making the bonds tradable on the stock exchange or on an organised market would enable cash constrained wage earners to access liquidity faster, even if at a discount, while other Greek citizens or corporations could acquire more bonds as savings instruments. Eventually, some bonds could even find their way abroad, which would be a sign of improving market conditions. Tradeability of the bonds could thus reduce some rigidities of the current adjustment programme. To ease tradeability, bonds should be issued in small denominations and they could mature at fixed dates in the year. Official creditors could put a floor under the value of the bonds with a pre-announced buy-in price for repurchases.

Tax rates on the interest income of the bonds should be low or zero. It is important that the bonds be at least as attractive for Greek holders as bank deposits at home or abroad. Banks could be compensated for this competition for popular savings and motivated to participate in the tradability of the bonds by some fees or by the possibility of using them as collateral in refinancing operations.

Partial payment in bonds doesn’t need to be limited to government-paid wages or pensions. Private firms could be made to buy bonds from the government to pay part of their net wages, or even part of their dividends. This could especially apply to nominal wage and dividend increases in the private sector until 2020 or at least until a key condition on country-wide export performance or tax revenue is reached.2 Firms would purchase bonds against cash at face value and at no transaction cost. Linking the phasing out of the compulsory payments in bonds to a few economic indicators that the press could easily monitor could make the general public aware of the evolution of these indicators and could generate popular support for the underlying performance to be engineered.

Exceptional circumstances may call for exceptional policy instruments. ‘Reconstruction bonds’ may add some perspective to the current adjustment programme of Greece. Greek people will understand that the government doesn’t have the cash or access to markets and so may well be more accepting of the compulsory bonds than at other times, provided it is well publicised that they are temporary. Domestic solidarity is needed until new income sources have been built, or until buyers appear for the bonds. A popular and active bond market could follow and could facilitate future macroeconomic stabilisation through government borrowing and spending of excessive private savings in recessions and through the redemption of bonds with budget surpluses in boom times. An active domestic bond market and more public attention for economic performance indicators would boost the saving habits of the country. Without making it a mercantilist hoarder, this would then preserve Greece from excessive current-account deficits and support a recovery of its historic glorious international trade.

Comments

Having recently read Reinhart and Rogoff's *This Time is Different*, I find you suggestion puzzling. Such compulsory bonds seem a vehicule of choice for a large-scale domestic debt default. Shoul difficulties linger, what would prevent Greece from transforming the maturity of bonds into something longer (or event perpetual) without any compensation ?

Moreover, your scheme harms the poorest the most. Firstly, it seems to work as a flat tax, whose regressive effects are well-documented. Secondly, the combination of wage adjustment and such a compulsory saving will make the whole working-class and a sizeable part of the middle-class cash-strapped and hence constrained to discart savings at a discount. This amplifies the regressive effect. Thirdly, tax exemption benefits, by construction, only people who pay taxes. Again, porrest households are flouted there.

Therefore, I believe that your proposal needs to comprise some elements preventing any form of domestic default (e.g. emitting the compulsory bonds under foreign law and without any form of collective action clause) and with a large element of progressivity.